Sundance kid not necessarily a wild bet

In the past two months, the price of oil has risen about 22 per cent, from $US77 a barrel to $US94. Meanwhile, in the past six months, oil and gas producers - big and small - have gone sideways or been heavily sold.

By InvestSMART · 13 Aug 2012

By InvestSMART ·
13 Aug 2012

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Which will correct? The oil and gas stocks, or the oil price?

Will there be a massive capitulation of the global oil markets because they realise that investors in companies such as Beach Energy, Drillsearch Energy, Sundance Energy and Molopo Energy have been right in selling their stock?

Radar thinks a more likely answer is that some of these companies have been sold off too aggressively.

The market for small-cap resources stocks has already staged a mini-fightback this month, but in the past three months the S&P/ASX Small Resources index is still down by about 17 per cent.

A big reason for the market's fear is uncertainty about funding, since mining is a very capital intensive business. Sentiment could also be damaged in the oil and gas sector by the revolution in shale gas and the dark art of fracking.

Because of the massive supply that has come on stream, the price of gas in the US has plummeted in the past two years, from $US13 per million standard cubic feet to almost $US2 per MMSCF.

So far there is limited substitution of oil for gas in the US, but equity markets look forwards and this might change as transport fleets are converted to run on liquefied natural gas.

One company in the middle of all this, and which Radar has mentioned before, is Sundance Energy whose shares, at 43?, have almost halved in the past five or so months.

Sundance has about 50 producing wells located in what analysts describe as the "hot spot" for shale oil and gas production: the Bakken region located primarily in North Dakota. The US Geological Survey estimates the region contains 3.65 billion barrels of oil.

The sell-off appears to be unjustified, first because oil, rather than gas, is Sundance's mainstay. About 75 per cent of its production is oil the remaining 25 per cent is gas, which is "liquids rich", analysts say, enabling Sundance to get a better price for it.

The main reason for Sundance's share price demise is that the market thinks the stock will need to raise equity funds. A quick look at Sundance's financial statements shows that it is running precariously close to the wind, with an operating cash flow of less than $10 million for this year, and capital expenditure and exploration costs in the region of $35 million. It is also due to spend about $75 million this year.

However, Bell Potter's senior energy analyst, Johan Hedstrom, says it is probable that the company will not need to raise cash, partly because of a $100 million debt facility. The company can draw down $25 million of it at this point, but this is based on its oil and gas reserves at June 30, 2011. Those reserves are under review, and should more than double, meaning an increased cash flow that will enable Sundance to draw down more funds.

The main reason for Hedstrom's confidence is that the sale of one of Sundance's Bakken assets, for between $150 million and $200 million, could go ahead as early as next month. .

Richard Hemming edits the fortnightly newsletter undertheradarreport.com.au

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Frequently Asked Questions about this Article…

Why have oil and gas stocks been sold off even though the oil price has risen recently?

Although the oil price rose about 22% in the past two months (from roughly US$77 to US$94 a barrel), many oil and gas producers — especially small caps — have been sold off because investors fear funding uncertainty for capital‑intensive mining and energy businesses. Sentiment has also been hit by the shale‑gas revolution and fracking, which has depressed gas prices and increased uncertainty about future demand and replacement energy sources.

How big has the recent oil price move been and what does that mean for investors?

The article notes oil rose roughly 22% over two months (from about US$77 to US$94 a barrel). For investors this divergence — rising oil but weak oil and gas stocks — suggests markets are pricing company‑specific risks (like funding needs and capital spending) rather than just commodity prices, so investors should look at company balance sheets and cash flow, not only the oil price.

What is the current financial and operational position of Sundance Energy as described in the article?

Sundance has about 50 producing wells in the Bakken shale region and about 75% of production is oil (25% gas, described as liquids‑rich). The article says its shares have almost halved over ~five months. Financially, Sundance showed operating cash flow of less than US$10 million for the year, with capital expenditure and exploration around US$35 million and total planned spending of about US$75 million. It also has a US$100 million debt facility, with roughly US$25 million currently available based on reserves at 30 June 2011.

Will Sundance Energy need to raise equity capital soon?

The market has been pricing in the possibility of an equity raise, which is a major reason for the share price fall. However, Bell Potter analyst Johan Hedstrom believes it is probable Sundance will not need to raise cash because of the US$100 million debt facility and the expectation that reserves (currently under review) should more than double, allowing Sundance to draw down more of that facility.

Why is the Bakken region important for shale oil and gas investors?

The Bakken (primarily in North Dakota) is described in the article as a 'hot spot' for shale oil and gas production. The US Geological Survey estimates the region contains about 3.65 billion barrels of oil, making it a strategically important area for companies like Sundance that have producing wells there.

How has the shale‑gas revolution affected gas prices and potential fuel substitution?

The shale‑gas boom has pushed US gas prices down sharply — the article cites a fall from about US$13 per million standard cubic feet to almost US$2 per MMSCF over two years. While there has been limited substitution of oil for gas in the US so far, equity markets worry this could change if transport fleets convert to liquefied natural gas, which would affect oil demand dynamics over time.

Are small‑cap resources stocks oversold and a potential buying opportunity?

The article suggests some small‑cap resources stocks may have been sold too aggressively: the S&P/ASX Small Resources index staged a mini rebound but remained down about 17% over three months. That could indicate opportunity for patient investors, but the piece also warns of genuine risks — especially funding and capital needs — so company‑level fundamentals remain critical.

How could an asset sale impact Sundance Energy and its investors?

Analysts cited in the article say the sale of one of Sundance's Bakken assets for between US$150 million and US$200 million could proceed soon. Such a sale would likely boost cash flow or allow debt drawdown, improve the company’s funding position and reduce the likelihood of an equity raise — factors that could materially change investor risk and the company’s outlook.